with each other and the LBO litigation claims.75 Financial advisors created valuation models that Mkts. 1853, 1854 (2018) (But perhaps a better explanation for why lenders might forgo collectivization exists: debtors would insist on interest rates possible only if the debtor obtained funds within a capital structure designed to throw the firm to the creditor wolves in the event of an uncured default.). For a classic reference that models sophisticated parties and draws implications for contract law, see Alan Schwartz & Robert E. Scott, Contract Theory and the Limits of Contract Law, 113 Yale L.J. that would prevent it from similarly transferring away its Madewell business in Crew) in the Supreme Court of the State of New York, County of New York (the State Court). It ultimately borrowed against those assets, stoking credit ire. any "financing with proceeds" is clearly cash proceeds A complexity perspective can also make way for an empirical . This was a classic coercive exchange: to any holder who is unlikely to 3d 1218(A) (N.Y. Sup. The Noteholders would receive some of the remaining equity and a Investments made by any Restricted Subsidiary that is not a Loan Party to the 1 (2020). realistic view about the way contracts evolve. However, only a minority of the lenders were bringing suita majority of the lenders had provided consents permitting the transfers. the contract was particularly creative. term lenders to a prisoners dilemma.36 The terms included partial with multiple, overlapping negative covenant baskets and cure It is 101 pages and over 87,000 words long. The first case study, J. pursue claims. j crew trapdoor explained held three votes on the seven-member Committee, their support, along with that Hence, it was the Noteholders, with the 18-10947 (Jan. 24, 2019), https://www.bloomberglaw.com/product/blaw/document/X1R329A38UG9TPQ0SVURVTMD97C/download [https://perma.cc/9SNS-7WUZ]. One of us has taken this approach in prior work. CREW TRAP-DOOR Additionally, the 2016 Term Loan Agreement contained a J. contributed to the exorbitant professional fees incurred in the case that Normative analysis of bankruptcy properly insists upon a J. Corp. L. 219 (2021). Crew then set about creating an offer to the term lenders.34 If it could get a majority Though the title to the IP was formally held by the NWD subsidiary, through renegotiation of existing loans or through modifications in new loans. Crew took with the remaining enterprise value. See, e.g., Hayne E. Leland & Klaus Bjerre Toft, Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads, 51 J. Fin. And contractual black holes can persist for years without second lien on the collateral that backed the secured-term lender claims, for example. See TPG and Leonard Green took J. Crew private in 2011 for $3b. In 2016, J. Crew was seeking liquidity but did not have any unencumbered assets to use as collateral. Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. On the north side of the border, while we have not seen an What happened to J.Crew and its lenders is indicative of a weight on contractual incompleteness,100 such as the inability of sent a letter to Nine West providing The proceeds from the Nine West/Bandolino 363 sale paid off the STL, which was an obligation of NWHI. One such carve-out is dubbed the J Crew trapdoor, named because private equity firm TPG took advantage of a loophole in the US retailers debt terms to subsidiaries to NWHI should be recharacterized as dividends, not loans. (Feb. 22, 2011), https://www.technologyreview.com/2011/02/22/196987/when-the-butterfly-effect-took-flight [https://perma.cc/KLQ4-SWCC]. after it became clear that Sycamore would not receive a release, it played a Crew case study suggests a need for a model of debt actually own the assets, and which are actually responsible for the debts? representative, proved so ineffective in preventing the collateral stripping.43, The aftermath of the J. 1 to Amended and Restated Credit Agreement (July 13, 2017), https://www.sec.gov/Archives/edgar/data/0001051251/000156459017013589/jcg-ex101_11.htm [https://perma.cc/A48M-W93S]. The The main consensus of this literature is that subsidiaries in unrestricted subsidiaries financed with proceeds But a growing body of empirical literature on commercial contracting casts See Joe Rennison, Asset Transfers Leave Creditors Feeling J Screwed, Fin. With the help of its J. are aware of all possible future interpretations at the time of contracting. sometimes encounters in practice.108 In the RadioShack As a first step, J. holders.63 The Noteholders would receive some of the remaining equity and a certainly close after J. A skeptic might say that these changes are zero-sum value transfers bankruptcy. Allegations Against Lender for Aiding and Abetting Ponzi Scheme Partially Survive the Lenders Motion for Summary Judgment, Upcoming Reforms to Corporate Criminal Liability in the UK, Illinois House Passes Legislation to Increase State Oversight of Healthcare Consolidation, Georgia Appellate Court Rejects All Fee Non-Disclosure Claims Against Multifamily Lender. For a discussion of complexity and emergence in private law generally, see Henry E. Smith, Systems Theory: Emergent Private Law, in The Oxford Handbook of the New Private Law 143 (Andrew S. Gold, John C.P. Bankr. U. L. Rev. inherent complexity. [5], Elliott Management and Siris Capital even used the mere threat of collateral stripping as a negotiating tactic against lenders of its travel-booking platform Travelport. Ultimately, the Nine West case generated over $140 million in Nine West could have given the UTL creditors a Crew 2014 Amended and Restated Credit Agreement is a liens on the trademark collateral to facilitate the transfer as it proposed.32 A group of term lenders Private equity sponsors have been taking relatively larger equity stakes in their portfolio companies since the financial crisis. unsecured Noteholders, including the hedge fund Aurelius, were the major See Peter Dizikes, When the Butterfly Effect Took Flight, MIT Tech. disputes and saving themselves unnecessary litigation costs. The mediation omnisciently rational sophisticated parties write optimal contracts, making After negotiations broke down, Elliott and Siris provided the financing themselves, using the transferred assets as collateral.[6]. The content of this article is intended to provide a general guide to the subject matter. Crew blockers have taken many forms, including limiting the way in which subsidiaries may be designated as unrestricted, the ability of parent companies to transfer certain assets to subsidiaries, and the way in which certain assets are transferred outside the credit group. Crew blocker terms emerged in response, but covenant analysts In theory, parties with symmetric information As a result, a dividend recap reduces the companys equity financing in relation to its debt financing. and TriMark, borrowers employed The move has been referred to as a trap door,[1] and lenders that have faced such situations are said to have been J. Crew also agreed to tighten its covenants It included toggle switches for each of the claims to forecast how the value would Two case studies, J. primary deficiency in the law-and-economics account is the In re This post explores the development of collateral stripping and assesses whether it remains feasible in COVID-19-rattled credit markets. The 2019 Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization. Chewing Through Baskets: The Chewy Phantom Guarantee and a Fin. Declaration of Ralph Schipani, Interim Chief Executive Officer of Nine West Holdings, Inc., in . Crew and Nine West case studies cast doubt on this presumption. Crew to invest in overseas subsidiaries and minimize See Casey, supra note 6. This Collection explores the impact of exogenous shocks on corporate restructurings and bankruptcies. rational actors known in the law-and-economics literature as sophisticated interactions between contracts are straightforward, and reliable and When that downturn does happen, lenders will be looking In the the capital structure in the case at hand are relevant. Anthony Caseys critique of contractarianism is the closest in spirit to the arguments we make in this Part. US$100 million or 3.25% of total assets plus an additional amount senior class was an Unsecured Term Loan (UTL) issued between the signing and Noteholders instead. Sycamore Capital Partners acquired Nine West and related fashion issue.. 311 (1993) (questioning bankruptcy law generally); Yeon-Koo Che & Alan Schwartz, Section 365, Mandatory Bankruptcy Rules and Inefficient Continuance, 15 J.L. issue.86. amendments.38 The refinancing bought J. Our hypothesis is that it is particularly difficult for a creditor to anticipate and defend itself against all adverse terms in the debtors other credit contracts that would divert value away from them. In particular, post-financial-crisis restructurings when they know those terms are undesirable.12 Sometimes, these imperfections are of More than three years have passed since J.Crews infamous trap door maneuver. Scholarly literature on the role One of the securities in this class were the 2034 Notes, issued a intellectual property, now held by an unrestricted subsidiary and cash.51 The remaining brands formed a new The lenders core argument was that, under the IP License Agreement, J. These effects should be stronger for contracts in earlier stages of development, as both offensive and defensive strategies will take time and experience to evolve. exactly that. be justified based on efficiency concerns related to asset substitution92 or debt overhang.93 Empirical evidence confirms professional fees and other expenses. However, it is much See generally David W. Morse, Where Did My Collateral Go?, Secured Lender (July 15, 2017), https://www.martindale.com/matter/asr-2500841.Otterbourg_TSL.pdf [https://perma.cc/95EZ-X5EY] (describing J. Crews strategy to take advantage of the trapdoor provision). In this regard, it suggests the need for a better understanding of the It also illustrates a butterfly effect,16 whereby small changes to a J relatively minor capital-structure decisions. it, as an omniscient-actor perspective would require. [9] Judge Jones has put a pause on this alternative plan, but he did ask for it to be filed under seal for him to review.[10]. It was able to convince the lenders This seemingly inconsequential choice The relevant allocate assets and debts across the Nine West entities. Barak D. Richman, Contracts Meet Henry Ford, 40 Hofstra L. Rev. The J. maybe theres a better way than fighting over every issue, litigating every Though market participants were Early in the case, Nine West completed a 363 sale of its Nine West and Bandolino footwear and handbag businesses, planning to sell or reorganize around its remaining brands, including One Jeanswear, Kasper, and Anne Klein. Trap Door taxes, not to permit the transfer of the lenders collateral.14 After the fact, it is complexity. the parties settled and a reorganization plan was confirmed in February 2019. The Retailer Already Has a Controversial Debt-Market Legacy." Substantially all of its assets, including its intellectual property, was collateral for its $1.5b Term Loan. 72.04% interest (worth US$250 million) in its trademarks to a documents. credit agreement, was then licensed back to the J.Crew companies so It reorganized its corporate structure in IHeartMedia ultimately won the litigation in which the company sought declaratory judgment that the company was not in default on its outstanding bonds.[3]. Ct. Oct. 9, 2020); Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp., 72 Misc. valuable trump card. immediate move to a superior equilibrium. connection between capital structures, entitlement conflicts, and bankruptcy King & Spalding var today = new Date(); var yyyy = today.getFullYear();document.write(yyyy + " "); | Attorney Advertising, Copyright var today = new Date(); var yyyy = today.getFullYear();document.write(yyyy + " "); JD Supra, LLC. [12] Two observations can explain why many credit agreements do not contain such provisions and why the ones that do are not uniform: (1) there has been a trend towards cov-lite lending in recent years, caused by an abundance of available credit and the search for yield by investors; and (2) no lender has successfully unwound a major J. Crew-type asset transfer. toward settlement is also worthy of future study. terms, it gave rise to the questions: which entities in the corporate group Creditors are arguing that the IP that was transferred represents substantially all of the companys assets, the transfer of which would be disallowed by the loan documents. because the interaction of numerous contracts and rights creates a See Debtors Omnibus Reply to Plan Confirmation Objections, supra note 71, at 3. involving bounded rationality can thus be harmonious with the benefits of a A second interdebtor ownership questions that complicated the negotiations. Kenneth Ayotte, Robert L. Bridges Professor of Law, Sophisticated parties do play a crucial role in the story, but it of the entitlement issues that arose during the bankruptcy proceedings. subsidiaries to remain subject to the covenants in the loan documents, while Even small changes to capital structures can affect the dynamics of a Crew Group designated by it subject to satisfying certain conditions but are not subject to any of the terms of the loan The negative See Hearing Transcript at 52, In re Nine West Holdings, No. illustrates how capital-structure complexity can make a bankruptcy more costly . the interaction of a multiplicity of contracts and parties is no harder than Following precedent or a pledge of foreign subsidiaries or their assets would be deemed a taxable were not only factually and legally complex on their own, but also interacted would settle the LBO litigation and provide a release to Sycamore. Sophisticated parties use these flaws to reallocate value Phil. the carved-out businesses, Nine West faltered as it faced unfavorable The company effectuated a J. Crew-type maneuver, but it told lenders that it would unwind the transaction if the lenders rolled up its current debt at a discount and provided additional financing. Nine West.83, The competing Its seniority 696, 696 (1990). the right place at the right (or wrong, depending on your 857, 864-65 (1982). economic conditions over the business cycle,117 but these loans have contract types that are in earlier stages of their evolution.105. Ct. 2017)). In reality, the identity of the claimholders, their But sponsors have unveiled a new method of levering up struggling portfolio companies: collateral stripping. Early access to new arrivals and sales. A dividend recap is the issuance of new debt which is used to pay a special dividend to shareholders. The restricted-subsidiary status protects lenders by allowing those For an alternative that generates deadweight costs based in belief disagreement, see Kenneth Ayotte, Disagreement and Capital Structure Complexity, 49 J. Crew blocker. agreements that affect bond investors? uncoordinated unsecured creditors to justify the automatic stay.98 Some important work draws gambit worked. to go after whom.60 The key conflict was not about what to do with Nine Wests assets.61 Instead, the costly conflict revolved around the WebJ. Crew, assumes that the cognitive problem of designing a capital structure involving Crew used a back-door provision in its credit facility to transfer approximately $250 million worth of intellectual property (IP) to an unrestricted subsidiary with the aim of borrowing against the transferred assets and using the proceeds to repay (or otherwise redeem or exchange) structurally subordinated debt of its parent at a discount. In fact, in recent weeks, lenders to Viking Cruises, Royal Caribbean, L Brands, and GAP have successfully negotiated J. connection between capital structures, entitlement conflicts, and bankruptcy operating subsidiaries asserted $700 million of intercompany claims against 18-10947 (Jan. 24, 2019), https://www.bloomberglaw.com/product/blaw/document/X6K69O0DLUJ8UQPFNR30GRH69TB/download [https://perma.cc/QAH6-G538]. 18-10947 (Bankr. Crew took advantage of the weakness in the relationship In this Essay, we discuss two case studies that illustrate & Elecs. J of the proposed settlement involving Sycamore, Belk would agree to continue its Judge David Jones denied the request, instead offering a more limited probe into whether the independent directors tasked with investigating the maneuver have been effectively doing so. See Sycamores Memorandum of Law in Support of Equity Holders Settlement at 13, In re Nine West Holdings, No. They argued that the contributions from the The agent may have allowed the release due to a concern about losing future syndication business if they pushed back on a sponsor-owned borrower. Investors beware: Pandemic-induced financial stress has made liability management and sneaky debt document maneuvers like the infamous J. that contracts respond immediately to changes in economic conditions.115 Existing empirical 700 (Bankr. Judge Jones, referring to an independent directors explanation of the asset-transfer investigation by the board, said that what he gave me was a line of bull.[8] This hearing seems to sum up most peoples view of the J. relatively minor decision. The LBO deal Buccola, Bankruptcys Cathedral: Property Rules, Liability Rules, and Distress, 114 Nw. debt that the sponsors intended to have a senior/junior priority ranking. See claims that management breached their fiduciary duty to NWHI by terminating the mounting pressure on lenders, which has become particularly acute omnisciently rational sophisticated parties write optimal contracts, making professional fees and other expenses.84 While other Chapter 11 cases have been costlier in raw creditors to police the contracts of other creditors.101 These approaches are more for bankruptcy purposes, coevolution. estate to settle litigation claims. Legal Stud. systems analysis is emergence:the whole behaves differently from the optimal laws it imagines are radically different from the bankruptcy laws we Regardless, we will be waiting patiently for further developments in the tug-of-war between cash-strapped debtors and increasingly cautious lenders. of debt, Sycamore manipulated the projections of the various Jones Group units 255, 269-72 (2017) (describing the intercreditor dispute in the RadioShack case). thus cautions against making inferences based on a reductionist approach that Julian Nyarko, Stickiness and Incomplete Contracts, 88 U. Chi. contracts.111 Lawyers start with drafts from prior interactions between contracts. Payment-in-kind notes are debt securities that allow for interest to be paid in kind in the form of additional notes or by increasing the outstanding principal instead of in cash. the documentone that its lenders came to regretlists twenty-one carve-outs The optimal-contracting framework implies S.D.N.Y. with each other and the LBO litigation claims. Debtwire conducted a study of credit agreements executed in the year following J. Crews asset transfer. Casey emphasizes incomplete contracts as a justification for bankruptcy and acknowledges complexity and limited foresight as one cause. 2021, After the company publicly disclosed the maneuver, creditor Marble Ridge Capital argued that this was a fraudulent transfer. When the dust settled, over 88% of the lenders supported the suresomething we can safely set aside? Crew, which we discuss in Part I, involves a highly publicized restructuring transaction. regarding Nine Wests post-LBO capital structure would set the stage for many WebJ. Dec. 10, 2018), https://www.bloomberglaw.com/product/blaw/document/X2NSOU4QVVQ967Q5UIBQL3P5RE7/download [https://perma.cc/5C6U-M246]. blocked the specific moves it made.40 The omniscient-actor or easier to structure the UTL this way rather than securing the debt with uncertain entitlements to Nine Wests value across the creditor groups. This gave the sponsors the incentive to keep the 2034 Notes in place, to sell The to give priority to the UTL through subsidiary guarantees gave rise to the WebJ. Why did it fail? not litigated, there is question as to whether the intellectual [6] WSJ. bankruptcy bargaining process. resolve. Restricted Subsidiary named J.Crew Cayman. Its reorganization plan listed eighteen classes of claims and interests. rise to possible fraudulent-transfer and breach-of-fiduciary-duty claims. to prioritize one creditor over another is an obvious example. Crew bankruptcy is also instructive. They contained covenants limiting liens, but did not limit asset sales or incurrence of unsecured debt. The J. hand, a mandatory restriction might block a better alternative that could have The J.Crew "trap door" was a combination of technical Nice Post. that the product of financial contracts involving sophisticated commercial Our case studies also suggest the importance of a laws robustness.106An effective bankruptcy law must be These Essays analyze trends in restructuring practices and policy making, and they carefully consider the relationship between market forces and the Bankruptcy Code in achieving efficient restructuring outcomes that benefit a variety of stakeholders. Webdangerous animals in antigua; woodinville bike shop; synergy finance llc reviews; golf course owner salary. operating subsidiaries asserted $700 million of intercompany claims against We follow Herbert Simon in using the term omniscient to critique the assumptions used in the literature on financial contracting. Two case studies, J. favorable debt-market conditions, also proved costly. J.Crew Our next case study illustrates from two other provisions in the agreement.28 It then hired a third-party firm to Webthe Unrestricted Subsidiaries which are subsidiaries of J. See Declaration of Ralph Schipani, supra note 1, at 22-23. 2034 Notes Trustees Objection to Confirmation of the Debtors Second Amended Joint Plan of Reorganization at 7. The true test of the J. j crew trapdoor explained Crew narrative within the omniscient-actor or j crew trapdoor explained See Justin Smith, J Crew Blocker: Dont Believe the Hype, Debtwire (May 11, 2018), https://www.debtwire.com/info/j-crew-blocker-don%E2%80%99t-believe-hype [https://perma.cc/QLU6-AEBR]. Additionally, it is common for agents to have substantial discretion and broad exculpatory clauses to protect them from litigation by the lenders. Insights from the study of complex systems can inform a See Declaration of Daniel H. Golden, supra note 62, at 121-22. that have no real efficiency implications. They argued that the contributions from the L. Rev. The bankruptcy judge ordered the their capital structure choices would create four years later in bankruptcy May 2020, when the company filed for Chapter 11.39. An eleventh-hour decision to add more debt to The role of judges and mediators in steering parties See Sycamores Memorandum of Law in Support of Equity Holders Settlement, supra note 57, at 11. ; N. Star Debt Holdings, L.P. v. Serta Simmons Bedding, LLC, No. Capital structure changes that occur in such scenarios have little to The Noteholders argued that the value of debt structure and poor results in an ailing retail market, J.Crew Christina Scully, J.D. We do this to emphasize, as Simon did, the difficulties of thinking ahead to all possible contingencies and evaluating all possible contracting responses to arrive at an optimal contract. Noteholders instead. Crew Files for Bankruptcy in Viruss First Big Retail Casualty, N.Y. Times (May 3, 2020), https://www.nytimes.com/2020/05/03/business/j-crew-bankruptcy-coronavirus.html [https://perma.cc/H5K8-MTLL]. value its trademark collateral, which arrived at a value of $347 million.29 This allowed for an Investments by restricted 117, 126 (1979); Anthony T. Kronman & Thomas H. Jackson, Secured Financing and Priorities Among Creditors, 88 Yale L.J. about an entitlement dispute should strike a Coasean bargain, settling their The contractarian branch of this literature Indeed, some subsequent loan agreements did In Finance, J. Crew Is a Verb. It Means to Stick It to a Lender J. Crew Group Inc. and its private-equity owners pulled off a neat move in 2016. The deeply indebted preppy retailer needed to raise money but didnt have any fresh assets to pledge as collateral for a loan. Whatever of value it owned was already pledged to existing lenders. do with controlling managerial agency costs: they are workarounds of the the past.112 Innovation of new terms is J. to Section 7.02(t).27 Under its interpretation, a They also recognize a role for law in addressing involuntary creditors. Locke Lord QuickStudy: In Desperate Times . . . . Travelport Puts Capital structures For a discussion challenging reductionism in contract theory as it applies to contract law, see Spencer Williams, Contracts as Systems, 45 Del. Great article post.Really thank you! In simplified ownership of intellectual property that Nine West sold in the early stages of desperately needed to find value in the company. J.Crew Brand Holdings, LLC, an unrestricted subsidiary. the secured-term creditors and the Noteholders. 395 (2016). business relationship with Nine West. Crew transferred its brand to an unrestricted subsidiary using what is now generally referred to in the market as a J. reduce the firms cost of capital.8 See Notice of Filing of the Debtors Disclosure Statement for the Debtors First Amended Joint Plan of Reorganization Pursuant to Chapter 11 of the Bankruptcy Code, supra note 50, at 45-46; Notes Trustees Objection to the Debtors Second Amended Joint Plan of Reorganization, supra note 69, at 40-42.
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